Digital VAT? A Tax Windfall If Latin America Finds Consensus
Countries like Argentina, Chile and Mexico have begun charging a value added tax (VAT) on digital purchases. But that may just be the tip of iceberg, especially if governments can reach a regional consensus.
SANTIAGO — "Hello, and thank you for using our services," says the website, before adding: "We'd like to inform you that from next month, due to fiscal changes in the country, your membership fee will rise with the increase in digital VAT."
In recent months, millions of users of digital services in Latin America have received messages along these lines, and for a simple reason: The digital boom that's been fueled by companies like Rappi, Netflix or Uber, to name just a few, has caught the taxman's attention. And in most cases, it's the consumer who pays.
Paola Soriano, head of consumer research for Latin America at the market intelligence consultancy IDC, says that these kinds of disruptive services — the transportation, food delivery, audiovisual entertainment or lodging sectors — are part of a new economic reality.
They've gained market share, she says, especially during the pandemic, and as such, Latin American is catching up with what was already a global trend. It's only logical, therefore, that tax systems would also adapt to include this new, and growing volume of business, Soriano adds.
Still, following the money is easier said than done. Challenges include the ability of such firms to engage in multiple activities and earn money simultaneously in several countries, without any significant physical presence there. Without tax residency in those countries — the traditional criterion for fiscal obligations — taxing their activities in consumer countries becomes difficult.
As the UN agency ECLAC points out in its 2020 Fiscal Outlook for Latin America and the Caribbean, multinational firms can pick and choose their residencies and operational centers in line with the fiscal pressures they face in any region. They then transfer their taxable utilities toward jurisdictions with little or no taxation.
This has currently made VAT (Value Added Tax) on digital services the most reliable means for governments wanting to taxing offshore firms operating in their country. And so far, it is proving a good first step for regional treasuries.
Leveling the playing field
Leonardo Hernández, a professor in public administration at Chile's Catholic University, sees it as an entirely reasonable solution in terms of economic efficiency. "They've simply leveled the playing field for other goods and services," he says. "There's no reason for exempting digital services."
In Chile, as part of recent fiscal reforms, the government began charging VAT on online services from July 1, 2020. Felipe Larraín, who twice served as the country's finance minister, most recently from 2018-2019, says that officials realized the absence of the VAT meant two things: less revenues for the state and unfair competition for the traditional economy.
Latin American is catching up with what was already a global trend.
As an example, he points to the way platforms like Airbnb compete with hotels without paying either VAT or income tax. "We couldn't see any reason why the digital economy, with all its advantages, should not pay taxes," Larraín explains. "That was the basis of the problem."
Gustavo López-Ameri, a tax partner at auditors Deloitte Perú, says that his country is keeping an eye on Chile's fiscalization of the digital sphere, and that the Peruvian government is mulling extending the sales tax (IGV) — already applicable to business-to-business operations — to the business-to-consumer (B2C) sector.
"If we consider it from the point of view of the consumer-natural person, it wouldn't be desirable," he says. "But from the point of view of taxation, the move is necessary and fair. In fact, Peruvian entrepreneurs who venture into a digital business selling to the world must pay the IGV, while foreign multinationals provide digital services to local users without paying the tax. These types of measures level the playing field."
Further north, in Mexico, a 16% VAT rate on digital products and services entered into force on June 1. That ends the unfair advantage foreign firms enjoyed, says Antonio Zuazua, a tax partner with auditors KPMG México. "Very clearly and obviously tax payment was due here," he says.
Víctor Aguírre López, a co-founder of the law firm BlackBox Startup Law, which advises startups, explains that the norm will soon affect many firms that aren't physically present in Mexico, and thus haven't had to pay taxes despite selling high-consumption digital services there.
KPMG reports that as of February 2020, 77 countries indirectly tax digital transactions and eight more are considering doing so. In Latin America, Argentina, Colombia and Uruguay were the first to apply the digital tax in 2018, respectively at rates of 21%, 22% and 19%.
Argentina later introduced more indirect taxes to digital transactions, and in doing so added $22 million to the treasury in the first three months of 2019. Uruguay earned $18.4 million in the first five months of that year, while Colombia's tax and customs authority, DIAN, reported that in January 2019 it earned some $12 million from digital VAT for transactions in the second half of 2018.
Ecuador and Paraguay joined the trend in 2019. Mexico and Chile followed suit by applying the VAT, starting earlier this year, and Bolivia, Peru and the Dominican Republic are likely to do the same in the near future.
As expected, most firms subject to this tax adjusted prices to pass the tax onto their consumers. "That means a service that would cost 100 pesos is now selling at 116; with 16 pesos in VAT," says KPMG México's Antonio Zuazua.
Startup advisor Víctor Aguírre López has a slightly different take. He says that when service providers raise their rates, they risk losing customers. "Consumers are sensitive to prices and may choose to look for substitutes," he says. But IDC's Paola Soriano says that even with the price hikes, the services these digital companies provide are still cheaper than the traditional alternatives, such as cable subscriptions or buying actual CDs or DVDs.
Most firms subject to this tax adjusted prices to pass the tax onto their consumers.
Soriano says that everything will ultimately depend on governments, which have difficult decisions to make, especially given the current economic context. Unemployment is on the rise throughout the region, and many of those who do work have only informal employment. She believes prices may rise, to be provisionally offset with temporary discounts, package prices or added services.
Room for growth
ECLAC, for its part, is advising regional states not to forego this key source of revenues as digital sales expand, in spite of the legislative complications involved. And it doesn't have to end with the VAT. A next step — and one that a number of governments are currently contemplating — could be to target revenues from sales in a given country.
Former minister Felipe Larraín, now a lecturer at Chile's Catholic University, says the challenge is finding the way to tax the proportion of a multinational's revenues that is generated in your country. He expects the Organization for Economic Cooperation and Development to make proposals on this.
López-Ameri of Deloitte Perú agrees. He says that what's needed is a standardized, regional taxation norm, and he expects that a consensus may soon emerge in the framework of OECD deliberations. Whether that means following the approach taken in France, which has been aggressive in how it taxes digital services, remains to be seen. But BlackBox's Aguirre, for one, does think decisions taken in Europe may come to have a big influence on Latin America.
For now, taxes on digital services generate only a modest amount for revenue for governments in Latin America. But as Larraín point outs, the sector is growing — at a faster rate than traditional retailing — and will continue to do so for the foreseeable future. "That's hey you have the solution in place before it becomes a very significant quantity of resources that is not being taxed," he says.